Retirement Planning

By Herbert K. Daroff, J.D., CFP

Mr. Daroff is affiliated with Baystate Financial Planning, Boston. He can be reached at

For my father’s generation, retirement income was based on the “three-legged” stool: Employer Pension; Social Security; and Personal Savings in approximately equal thirds. That stool is a bit wobbly today. Employer pensions are just about gone. Social Security for highly compensated individuals like business owners, executives, and professionals is a much smaller percentage of retirement income. Therefore, we have to rely on personal savings, both qualified plan accounts and taxable (non-qualified) investments and savings.
Fidelity Investments identifies five (5) retirement income risks:

Longevity: Will I outlive my retirement accounts?

Asset Allocation: What have the ups and downs of the market done to personal savings? How about low interest rates?

Inflation: How will my standard of living be affected by the increased costs of the goods and services that I need?

Healthcare/Custodial Care: How severely will I diminish my retirement income savings if I need expensive medical or custodial care? What will be covered by the government?

Withdrawal Rate: How much do I need to withdraw each year from my accounts net after other income received in retirement, like Social Security?

Will I receive Social Security? How much? For how long?
For most retirees, I think that those are the risks. However, for the highly compensated, there is a sixth (6th) risk to consider. At what income tax rate will my qualified plan distributions be reduced? So, the issues are security of income and amount of income in order to provide the desired lifestyle net after taxes, inflation, and uncovered expenses.

For years when they ask, “Will I have enough to retire?” My reply has been, “Sure, if you die soon enough.” I explain to them that in order to answer their question I need for them to answer a few of mine, including:
How long will you live? What will income tax brackets be between now and then?
What will inflation be between now and then? Will they have uncovered expenses (like medical or custodial, but not limited to those? If so, when? And, how much will they cost? What will your lifestyle cost?

We cannot answer the question. What we can do is manage the risks.

As a result, I think that the NEW three-legged stool is a combination of:

Assets Under Management (both qualified and non-qualified);

Guaranteed Income Contracts (fixed and variable annuities with lifetime benefit riders, and other hedged accounts); and

Life Insurance (to replace principal for a surviving spouse and/or descendants and to fund the income taxes on a Roth Conversion at death)

Clients, especially highly compensated clients who want to keep their lifestyle during retirement, need to be able to select where to take their retirement income.

First, you have to take required minimum distributions even if you are in a higher tax bracket in retirement that you were in when you contributed the funds. And, even if the market value of those accounts has declined.
Second, you need to select where to take the remaining income needed to maintain your retirement lifestyle.
Do you take any other funds from those accounts? Distributions from qualified plans and IRAs work best if you are in low income tax brackets. Some years in retirement may have lower income tax brackets. Who knows.

Do you take distributions from non-qualified accounts? Distributions from your taxable accounts work best when markets are up.

But, what if investment markets are down?
You need to have one or more hedged accounts which include variable annuities with lifetime benefits (funded with qualified and/or non-qualified accounts) as well as qualified and non-qualified accounts that have been financial hedges including puts, calls, collars, etc.

Who wouldn’t want to have stock market opportunity with income security? Imagine a client who comes to you and says, “I want aggressive growth for my investments and I want conservative income.” What would you do? These hedged accounts can provide just that.

What if tax brackets are up?
You need to have funds that are accessible tax-free or that are subject to lower tax brackets. These would include dividend paying stocks (if dividends continue to be taxed at a lower rate that other ordinary income), investment principal accessible at capital gains rates (if they, too, remain lower than ordinary income rates), and Roth (IRA and/or 401(k)) or Roth Look Alike accounts (cash value of life insurance).

Even if you don’t have Roth accounts for your retirement income, you can provide Roth Accounts for your surviving spouse and descendants. If you have sufficient life insurance in place at the time of your death (imagine that, life insurance for the rest of your life), the funds needed to pay the income taxes on a Roth Conversion at your death can be paid using the life insurance death benefits.

A spousal IRA rollover can (under current law) convert to a Roth IRA. An inherited IRA cannot. You could make a death bed Roth Conversion, even on New Year’s Eve. Then, the following April 15th, look in the mirror. If you are there (you didn’t die), you can reverse the Roth election. If you are not there (you died), your family will have received the death claim proceeds in time to pay the income taxes on the conversion.

If my financial plan shows that I have $1,000,000 in my IRA at the time of my death, my wife will have the use of only $600,000 (today, but maybe only $500,000 or less later on due to higher income tax brackets). However, if I have $400,000 (or more) of life insurance that is in-force at the time of my death, then she can use that money to pay the income taxes on her Roth Conversion. Now, she would have a $1,000,000 Roth IRA continuing to grow with taxes deferred, but distributions would now be available to her tax-free.

During accumulation, we have all learned that dollar-cost-averaging works. 401(k) plans have institutionalized dollar-cost-averaging. Every pay period you allocate the same amount of money to the same funds, ETFs, ETNs, or securities. However, the amount of each asset class that you buy differs since the price of that asset class changes.
During distribution, however, dollar-cost-averaging can kill your retirement accounts. In order to create the most risk managed retirement income plan, you need to be able to draw income from the right place. Retirees need to be able to select from

their Assets Under Management accounts (one of the three legs on our stool), which are not hedged — which work best when investment markets are up
– qualified plan and IRA funds, beyond RMDs, when income tax brackets are down
– Roth accounts when income tax brackets are up
n their Guaranteed Income Accounts (another leg on our stool, for qualified and/or non-qualified accounts), which are hedged — which work best when investment markets are down
– qualified plans and IRA funds, beyond RMDs, when income tax brackets are down
– Roth accounts when income tax brackets are up, and
n their Life Insurance
– if there is cash value, works best when tax brackets are up, and then
– death benefits
– regardless of whether markets are up or down and
– regardless of whether tax brackets are up or down
– to replace principal used during lifetime and/or fund Roth Conversions for qualified plans and IRAs.
One of the greatest privileges of being a financial planner is the ability to tell a client who has been saving for a rainy day that it is raining now. It’s ok to start using the money that you have been setting aside for all of these years. If the client’s plan includes life insurance, then it’s ok to tell them that they can invade principal, too, in order to meet their retirement income planning needs knowing that that principal will be replaced for the benefit of their surviving spouse and/or descendants.
Remember, if the client has charitable inclinations, the best assets to transfer to charity at death are the qualified plan and IRA funds. However, be sure to segregate those funds for charity from those funds that will be used by a surviving spouse and/or descendants. If they are commingled, then the funds have to be withdrawn within five years of death. There is no limit on the number of IRA accounts that you can have.
One of the best? Oh yes, life insurance is also a great way to leverage the charitable inclinations of business owners, executives, professionals and other highly compensated clients into substantial charitable bequests to advance healthcare research, higher education, arts and music, and so much more. Works very well for the not so highly compensated, too.